How to Set Up a Charitable Remainder Trust

A charitable remainder trust is an irrevocable trust designed to achieve two goals simultaneously. It provides a potential income stream to a donor or other designated individuals for a set period, while also securing a future gift for a charitable organization. This structure allows an individual to convert assets into a source of payments for non-charitable beneficiaries. At the conclusion of the trust’s specified term, the remaining assets are transferred to the chosen charity.

Information and Decisions Required for Setup

Choosing the Trust Type

The first decision is selecting between two structures: a Charitable Remainder Annuity Trust (CRAT) or a Charitable Remainder Unitrust (CRUT). A CRAT has a fixed payment structure, paying a specific dollar amount to the income beneficiary each year. This amount is calculated as a percentage of the assets’ initial fair market value and remains constant for the trust’s entire term. No additional contributions can be made after a CRAT is established.

A CRUT offers a variable payment. The annual distribution is a fixed percentage of the trust’s asset value, which is recalculated each year. This means the payment amount can fluctuate with the trust’s investment performance. Unlike a CRAT, a CRUT allows for additional contributions after its initial funding.

Selecting the Parties

Establishing a trust requires identifying four roles.

• The Grantor, who is the individual creating and funding the trust.
• The Trustee, who can be an individual, bank, or trust company with a fiduciary responsibility to manage assets, make investments, and ensure distributions are made.
• The Income Beneficiary, the person or persons who will receive payments from the trust. The Grantor often names themselves, but it can also be a spouse, children, or another non-charitable party.
• The Charitable Remainder Beneficiary, the qualified 501(c)(3) organization that receives the trust principal when the term ends. The grantor may name more than one charity and can retain the right to change the beneficiary.

Determining the Payout Structure

Setting the payout rate for the income beneficiary is a significant decision. IRS regulations require this rate to be at least 5% but no more than 50% of the trust’s value. For a CRAT, this percentage is applied to the initial value of the trust assets, while for a CRUT, it is applied to the annually revalued assets. The choice of payout rate directly impacts the financial outcome for both the income beneficiary and the charity.

Another rule, the 10% remainder interest test, must also be met. This IRS requirement stipulates that the present value of the charity’s remainder interest must be at least 10% of the initial contribution’s value. This test can limit the maximum payout rate or the length of the trust term. The payment frequency must also be decided, with options including monthly, quarterly, semi-annual, or annual distributions.

Establishing the Trust Term

The trust’s duration, during which income beneficiaries receive payments, must be clearly defined. There are two options for the term. The first is a fixed period of years, which cannot exceed 20 years from the trust’s creation.

The second option is to base the trust’s term on the lifetime of one or more living income beneficiaries. For example, the trust could provide payments for the life of the grantor or for the joint lives of the grantor and a spouse. The trust terminates once the last income beneficiary passes away.

Identifying Assets for Contribution

A wide range of assets can fund a charitable remainder trust. Common assets include cash and publicly traded securities, such as stocks and bonds. Donating appreciated securities can be particularly advantageous, as the tax-exempt trust can sell the assets without immediately triggering capital gains taxes.

More complex assets, such as real estate or stock in a closely held corporation, can also be contributed. These assets require a formal valuation to establish their fair market value. This involves obtaining a “qualified appraisal” from a “qualified appraiser,” as defined by IRS regulations.

Drafting the Trust Agreement

The trust agreement is the legally binding document that formalizes all decisions made during the planning phase. It outlines the trust’s administration and operation, ensuring all parties understand their roles and responsibilities. The agreement formalizes the core decisions, such as naming all parties, defining the trust type (CRAT or CRUT), and specifying the payout structure and term. It also details the trustee’s powers and includes provisions required by the IRS to maintain the trust’s tax-qualified status.

It is necessary to hire an experienced estate planning or tax attorney to draft the agreement. An attorney will ensure the document complies with all federal and state laws, which helps avoid potential disqualification or legal disputes.

Executing and Funding the Trust

Obtaining a Taxpayer Identification Number (TIN)

After the trust agreement is drafted, the trustee must obtain a Taxpayer Identification Number (TIN) from the IRS. The trust is a distinct legal entity and cannot use the grantor’s Social Security Number. The trustee must apply for an Employer Identification Number (EIN) by submitting IRS Form SS-4. The EIN is required before the trustee can open any financial accounts in the name of the trust.

Signing the Trust Agreement

The trust is legally created when the grantor and trustee sign the agreement. The signing is done in the presence of a notary public, who verifies the identity of the signatories and witnesses their signatures. This notarization makes the agreement a legally valid contract.

Transferring Assets to the Trust

The final step is to fund the trust by transferring the selected assets. The process for transferring assets varies by type. For cash, the trustee opens a new bank or brokerage account in the trust’s name using the EIN and deposits the funds. For securities, the grantor works with their brokerage firm to retitle the assets in the name of the trust.

For real estate, an attorney must draft a new deed transferring ownership to the trust. This deed must be recorded with the appropriate government office to finalize the transfer.

Initial Tax Compliance

Once funded, the trustee must track all financial activity, including all income received, investment gains or losses, expenses paid, and distributions made. This record-keeping is for the trust’s annual tax filing. The trustee must file Form 5227, “Split-Interest Trust Information Return,” with the IRS each year to report the trust’s financial activities.